Last week, the publication of JIT report on fake accounts inspired an emotive debate on social media. The twitterati wondered whether bankers are blackmailed by politicians in power into doing their bidding. Folks also asked whether the otherwise hyperactive audit and compliance arms of the central bank willfully look the other way.
While their may be some truth to bankers finding it hard to say no to politicos, when banking regulations are broken; more often than not, the circumstances are inverted. Talk to most seths, the cherished class of corporate banking customers, and they will regale stories of how their relationship managers held their hands in side-stepping the law, often times leading the way.
And the lazy eye (look the other way) disease infects banks of all colour and sizes. Most of the time, the violations cause little immediate harm, and dismissed on grounds of lack of materiality. Take for example, the end of year routine inflating of balance sheets.
Sales personnel in almost every industry are prone to pushing volumes by cutting margins near year end cycles. Bankers behave no differently when they place short term advances with customers in one- and three-month maturities at exceptionally low lending rates, often less than Kibor.
What’s different is that the lending is done with “a pre-payment option with no penalty” clause, and a tacit understanding between the parties that the loan will be called immediately after year end book close. Similar strategy is employed on the liability side, where term deposits are placed at exorbitantly high savings rate in less than six-month maturities, but “broken” with no penalty within a week of new year.
No law is broken: the borrowing party is saved from paying mark-up on an amount it did not need but agreed to avail to maintain relationship; and the depositor gets a nice interest rate for a small interval.
Except, then the auditors beckon demanding confirmations, and bankers happily comply. On both ends, banks’ balance sheet shows increase in deposits which aren’t really there, and the depositor discloses a high-yield term deposit that won’t earn the interest it says it would.
Except that benign little trick is a vicious cycle that keeps inflating annual growth targets, leading to ever increasing reliance on ghost loans and deposits. Still, its benign compared to lending long-term to one group company of a high-rated obligor, with a promise to have them place similar amount through a different group entity in banks’ debt-issue, thereby ensuring that bank’s issue is over-subscribed. The bank gets to retain its good credit rating; while the customer is further compensated for the spread between the rates by knocking 50 odd bps off pricing on trade services in subsequent periods.
Or, when legal counsels are changed to get favourable opinions. For example, when a loan facility is extended to a high-risk borrower against collateral of shares of a blue-chip stock owned by sponsors. Except that the blue-chip is an associated undertaking because the sponsors’ children serve on the board or as executives. Does it count as the same sponsor family if the children are of-age? The beneficial ownership principle may leave some room for ambiguity; however, not if the same sponsor has taken out full page newspaper ads in the past, proudly claiming ownership of both businesses (and of sons!).
And when a favourite customer is going through a bad patch, the debt to equity covenant is in breach, or accumulated losses have led to a negative equity. The sponsor is unwilling to put more of his smart money as equity, because he knows that’s money down the drain forever. So, the bank extends a personal loan facility to the sponsor, knowing the family name is good for what it owes, and the sponsor places it back into the business as subordinated loan. The covenant is met and everybody goes home happy.
Blame poor regulatory oversight or ambiguous rules, or just routine business, fact is, the industry employs perverse methods whether the customer is a politico or not. That’s not to say bankers are bad people. The industry is starved off commercial lending because the government and PSEs comes kicking the door ever so often, dangling sovereign guarantees. The seths are risk averse and sitting on excess cash, only enticed to genuinely borrow long term for guaranteed return investments in IPPs or wind farms. Risky lending is thus genuinely disincentivized. What little honest lending happens in trade loans is further scared away by exchange rate volatility.
It is easy to grandstand and claim crowding out of private borrowing is no excuse to circumvent rules. Because to be fair, deviants are found in every line of business.
But unless the structural issues facing the industry are addressed, those who outwit the rules to achieve targets will continue to be rewarded. If some of them go a step further and route funds through fake accounts for customer’s pleasure, the difference is of degree, not principle.
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